CFM22110 | Accounting for corporate finance: Old UK GAAP excluding FRS 26: lenders: accrual accounting: discounted securities

The following guidance covers Old UK GAAP (applied before 2015) where FRS 26 was not applied.

Accounting for discounted securities

A discounted security is one acquired at a discount to its face value. The same accounting applies to a security issued at face value and redeemable at a premium (or any combination of discount/premium on acquisition and discount/premium on redemption). The return to the lender comprises the interest received on the bond plus the difference between the purchase price and the redemption price.

Example

On 1 January 2008 Company A lends £800,000 in return for a £1M bond in Company J. The bond pays interest at 2%. The bond is redeemable in 5 years (31 December 2012) for £1M.

This means that the total return to Company A as lender is the £200,000 increase in the value of the bond together with five year’s interest of £20,000 per annum. This is the equivalent of a fixed rate loan of £800,000 with an interest rate of 6.9%. (This is based on the assumption that all but £20,000 of the interest each year is rolled up into the balance outstanding).

The accounting is set out below:

In the year ended 31 December 2008, the bookkeeping would be:

The finance income of £55,200 amounts to 6.9% of the opening balance on the bond of £800,000.

As at 31 December 2008, the balance on the loan due from Company J will have increased to £835,200 (being the £800,000 balance at the beginning of the year plus finance income receivable of £55,200 less finance income received of £20,000).

In the following accounting period (31 December 2009) Company A will record finance income of £57,600. This represents 6.9% of the opening carrying value of the loan of £835,200.

The bookkeeping in this accounting period would be:

As at 31 December 2009, the balance on the loan to Company J will amount to £872,800 (being opening balance £835,200 loan plus finance income receivable of £55,600 less finance income received of £20,000).

In the subsequent accounting periods, the balance on the loan to Company J will increase, so that as at 31 December 2012 immediately before the loan is repaid and interest for 2012 is paid, the balance will be £1,020,000, being £1M due from Company J plus the 2% interest due in 2012: